Many investors are still learning about the various metrics that can be useful when analyzing stocks. This article is for those who want to know about Return on Equity (ROE). We Carriage Services, Inc. (NYSE:CSV) , as an example.
Return on equity or ROE is an important factor considered by a shareholder as it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Carriage Services
How do you calculate return on equity?
ROE can be calculated using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Carriage Services is:
30% = US$41m ÷ US$137m (based on the trailing twelve months to December 2022).
The ‘return’ is the annual profit. So, this means that for every $1 of its shareholder’s investment, the company makes $0.30 in profit.
Do Carriage Services Have a Good Return on Equity?
Arguably the easiest way to assess a company’s ROE is to compare it to the average in its industry. However, this method is only useful as a rough check, since companies vary greatly within the same industry classification. Happily, carriage services have a better ROE than the consumer service industry average (8.3%).
ROE
This is clearly positive. With that said, a high ROE doesn’t always indicate high profitability. Especially when a firm uses a high level of debt to finance its debt which can boost its ROE but high leverage puts the company at risk.
How does debt impact return on equity?
Companies usually need to invest money to increase their profits. That cash can come from issuing shares, retaining earnings or debt. In the first two cases, ROE will capture this use of capital to grow. In the latter case, the loans used for development will improve returns but will not affect total equity. Using debt in this way will boost ROE even if the basic economics of the business remain the same.
Combination of carriage services debt and its 30% return on equity
We think that Carriage Services utilizes a significant amount of debt to maximize its returns, as it has a fairly high debt to equity ratio of 4.29. Its ROE is clearly pretty decent, but it seems to have been boosted by the company’s significant use of debt.
Summary
Return on equity is a useful indicator of a business’s ability to generate profits and return them to shareholders. On our books, the highest quality companies have high returns on equity despite low debt. If two companies have the same ROE, I would generally prefer the company with less debt.
But ROE is just one piece of a larger puzzle, as high-quality businesses often trade at high multiples of earnings. The rate at which profits are likely to increase, relative to expectations of profit growth at current prices, should also be considered. Then you might want to take a look at this data-rich interactive graph of company forecasts.
Absolutely Carriage Services May Not Be the Best Stock to Buy, so you might want to check it out Free A collection of other companies with high ROEs and low debt.
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This article from Simply Wall St is general in nature. We only provide commentary based on historical data and analyst forecasts using an unbiased methodology and our articles are not intended to provide financial advice. It is not a recommendation to buy or sell any stock, and does not take into account your objectives, or your financial situation. We aim to bring you long term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall Street has no position in any of the stocks mentioned.
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